“You were in a terrible car accident: you were hit by a bus,” the doctor says gently. “You’ve been in a coma.”

“How long?”

The doctor glances nervously at her colleagues. “A long time, I’m afraid.” She pauses again. “Three years.”

It takes a few seconds for this to sink in. Three years? Your mind is filled with just one urgent question. “I gotta know, Doc. Give it to me straight. How have the markets been doing?”

Again the doctor looks nervously at the rest of the medical team, and they avert their eyes. “I’m sorry,” she says. “It’s been an absolutely terrible time to invest—the worst I’ve ever experienced. Europe is on the verge of collapse. The U.S. government is a financial basket case—it even had its credit rating downgraded. Japan had a devastating tsunami that caused a nuclear disaster. Iran may go to war with the U.S. Interest rates are at all-time lows. People are saying gold will hit $10,000 an ounce. And it looks like the Leafs will miss the playoffs again this season.”

You’re floored by the news. The last thing you remember before that bus struck your car on March 8, 2009, was listening to a radio report about how “investors are potentially standing on the precipice of another Great Depression.” In fact, you were planning to sell your whole Couch Potato portfolio and move to cash as soon as you got home. But you never made it, and now it’s too late: the nightmare has come true. You must be wiped out.

Pulling yourself up in the bed, you demand that someone hand you a laptop, and you go online to read the bad news for yourself. You go to the iShares website and check the three-year annualized returns on several of your index funds, and here’s what you find:

iShares S&P/TSX Capped Composite

18.7%

iShares S&P/TSX SmallCap

29.3%

iShares S&P/TSX Capped REITs

37.0%

iShares DEX Universe Bond

7.0%

iShares DEX Real Return Bond

15.8%

That can’t be right, you think. The doctor said that the last three years have been the most difficult in recent memory. But these returns look like they’re right out of the 1990s bull market. “I guess Canada made it through unscathed,” you think. Then you tap the keyboard and visit Vanguard to see how the international markets did, expecting to see blood spill from the screen. But what’s this?

Vanguard Total Stock Market

26.7%

Vanguard Small-Cap

33.3%

Vanguard MSCI EAFE

20.1%

Vanguard MSCI Emerging Markets

32.3%

“Doc, you must have been mistaken,” you say. But when you glance up from the screen you see the doctor is frantically trying to resuscitate the patient in the next bed. “Clear!” she shouts as she zaps him with the defibrillator. His body jerks violently, then slumps motionless. “Again!” she shouts, hitting the patient with another charge. But the heart monitor shows a flat line—it’s too late. “He’s gone,” the doctor intones.

You take one more look at your laptop screen, still trying to reconcile the numbers with the doctor’s account of the past three years and the corpse in the next bed. Finally, it comes to you in a moment of clarity—you’ve figured out the secret of investment success.

“Hey, Doc,” you say. “Do me a favour, will you? Put me back in the coma.”

35 Comments

Ha ha, great way to portray it!
While Byan Hold has sadly passed away, his friend Reb Alance should still be by your unconscious side to make sure you do even better in your newly induced coma. Or perhaps the doc can knock you out for one year at a time, so in the brief 5 minutes before going comatose again you can give a quick call to Reb to take care of business :)

Great piece Dan, very creative.

Chris
March 8, 2012 at 9:19 am

Is it really reasonable to look at returns by cherry picking a starting point that was effectively a generational low? If you look any further out, the returns are still pretty abysmal, e.g. the 5 year total return of VTI is only 2.2% annualized (during a period that averaged 1.99% inflation).

@Chris: I’m just having some fun here, but you’re of course right that everything depends on start and end dates. It works both ways: the 5-year numbers are poor because the start date is just prior to the financial crisis, and the 10-year period starts at the tail end of the tech crash. When the 10-year numbers start in 2003, they will look very different again.https://canadiancouchpotato.com/2011/12/04/why-you-should-beware-of-first-dates/

I don’t mean to pretend that everything is rosy, but don’t you find it a bit odd that the 2008 hangover has lasted this long? I hear from readers almost every day who are paralyzed with fear and “waiting for things to calm down.” At what point do you declare that things are calm? And by that time, don’t you think the ship will have already sailed?

SterlingF
March 8, 2012 at 9:33 am

“The doctor injects a clear substance into your IV and you are slowing drifting back into your investing paradise when you realize, I FORGOT TO REBALANCE!”

Phil
March 8, 2012 at 10:57 am

So funny and true:) passive buy and never sell wins.

VS
March 8, 2012 at 11:35 am

Pulling yourself up in the bed, you demand that someone hand you a laptop. A nurse gives you an iPad. “It’s worse than I thought!” you say. “People can’t even afford keyboards anymore!”

@Brian: The Vanguard returns are expressed US-dollar terms, for one. Also, the exact start and end dates can make a big difference, and the rolling three-year returns on mutual fund websites change every day.

I’ve been reading a lot of your website and appreciate all the advice. This particular article was brilliantly funny! Anyway, do you ever worry that the North American markets do what Japan’s markets did? It seems with all the negative news, that is not out of the realm of possibility. I’m so tempted to keep my money under a mattress and lose on inflation but at least I wouldn’t be losing big. Right now the markets seem to be doing well but with all the uncertainty and huge debt the US and many European countries, we could be in line for a 20 year run like Japan in the 90s and 00s. It seems like a bad time to start investing. I could be wrong but it seems like a couch potato in Japan would not have done well – I’ve looked on your website and haven’t seen an article on this. I would be curious as to your thoughts. Thanks.

Joe S
March 10, 2012 at 9:13 pm

Stock prices in Japan were hyper inflated in 1989 when the Nikkei 225 peaked. The average price to earnings ratio of the market was over 100.

If stock prices ever tanked here without a subsequent massive drop in corporate profits, companies would simply buy up all of their stock cheap with their massive hoards of cash, which are at record levels. Think of it as a safety net :-)

North American P/E ratios are around 15, which means they are already priced 85% lower than the Nikkei 225 at its peak, thus is a huge margin of safety for that kind of drop again.

Small Potatoes
March 10, 2012 at 10:15 pm

LOL @ “waiting for things to calm down.” more like “waiting for this excellent investment opportunity to end so I can buy in at a high point and enjoy mediocre returns”!

Charlotte S
March 10, 2012 at 10:21 pm

I have heard of actively managed ETFs coming into the market (or are they already here?), and I am curious where that might lead in the future. I can’t imagine they are a good thing.

@Charlotte S: Actively managed ETFs are already here in Canada. Horizons ETFs offers a number of them, but there are even a couple Claymore and iShares products that might qualify. They offer lower costs than most actively managed mutual funds, but it’s important to remember that there’s nothing inherently superior about ETFs. The Couch Potato strategy is founded on passive management, not on the ETF structure.

@Non Resident: Of course, no one knows what the future holds. But it should be pointed out that the long slide in Japanese stocks began with an enormous bubble, when stocks were extraordinarily expensive. The same is also true of the last 10 or 12 years in US stocks: at their peak, the S&P 500 was trading at something like 40 times earnings, almost three times the historical average. That isn’t the case now, by any stretch.

It’s also important to remember that the Couch Potato strategy calls for global diversification across many asset classes. The Japanese investor who invested 100% in Japanese stocks would have done poorly indeed, but if she had held a global portfolio she would have shared in the huge 1990s bull market in the US.

Some people seem to want the Couch Potato strategy to guarantee excellent results, in every country, over every period. Unfortunately, no investment strategy can do that. All the CP can do is diversify risks as much as possible, and keep costs as low as possible. That’s not perfect, but it’s the best we can do.

Andrew
March 11, 2012 at 1:48 pm

John Hussman, a big money manager who is conservative, has a 5 metric test that indicates equity markets could have a severe correction:
• The Standard & Poor’s 500 trading at more than 8% above its 52-week exponential moving average

• The S&P 500 up more than 50% from its four-year low

• The “Shiller P/E,” based on the cyclically adjusted trailing 10-year earnings, developed by Yale economist Robert Shiller, greater than 18; it’s currently 22

• The 10-year Treasury yield higher than six months earlier

• The Investors Intelligence’s bullish advisory sentiment over 47%, and bearishness under 25%; in the latest data, the numbers were 47.9% bulls and 26.6% bears

When these five conditions were met here is what ensued (quoted):
“In 1973, a 48% collapse ensued over 21 months, and in August 1987, there was a 34% plunge over the following three months. Since that ancient history, losses of 10% to 18% ensued in the 1998-2000 period, followed ultimately by a plunge of more than 50% in the dot-com bust of 2000-02. And in 2007, a correction of 10% culminated in the 50%-plus plunge of 2007-09”

Reading Hussman’s weekly commentaries is always instructive.

I think it is prudent to add an overlay of risk management on the index/rebalance strategy presented here. A simple one is to not be in a market that is 1% below its 10 month moving average. Alternately use a set of metrics like Hussman.

John Lever
March 11, 2012 at 1:54 pm

Hi Dan,

Your article is excellent :)

I have been using the Couch Potato strategy since Jan 2012. I am a fairly new potato :) I was wondering why the couch potato strategy doesn’t include dividend paying ETF’s? Rob Carrick has recently written some articles for the globe on choosing dividend stocks. Are there any that you recommend?

I currently have a growth portfolio of 70% Equity and 30% Bond’s but, plan to lower my equity portion to 50% with new money I have to invest on the advice of Charles Farrells’ book “Your Money Ratio’s”. Also, because it’s impossible to know where the market is going.

It is recommended by Charles Farrell that for the bond portion of your portfolio to use Intermediate Term (1-5 year) US Treasury Bonds. I currently hold only VSB – Vanguards short-term Bond ETF. For a Canadian investor should I hold Canadian Government Bond’s such as Canada Savings Bond’s instead of the US Treasury Bonds (will be held in a RSP). Or should I just continue buying Vanguards bond ETF as it holds both Government and corporate bonds with varying maturities.

I decided to buy my first stock: Berkshire Hathaway “BRK.B” but, my core holdings will forever use the Couch Potato Strategy. I’m looking forward to when you will update your take on Vanguard’s new Canadian listed ETF’s.

@John: In my opinion, dividend ETFs only make sense for investors who are specifically looking for tax-advantaged current income. I don’t believe there is good reason to expect dividend ETFs to outperform broad-market ETFs over the long term. You might be interested in looking back at a long debate on this topic from last year:

I am in the Air Force and just got word that we are going to be losing our severance pay as of last month. The following 3 options are available to us:

1. Take whatever severance we had accumulated in march next year.

2. Take some of the severance at that time and the rest upon release from the forces.

3. Take all accumulated severance upon release from the forces.

I have accumulated 13.5 yrs of severance which amounts to approx $18.5K (one weeks pay per year served, pro rated for partial years), this amount happens to coincide with my current RRSP contribution room.

Scenario 1: I could elect to take the money upon release (which would be at least 12 yrs from now) and let any future pay raises and promotions increase my total amount payable. I did a rough calculation based on moving up two more ranks at the highest pay incentive and adding around 1.5% per year for pay increases, which brought my total after 12 yrs to just shy of $28K. I would then roll that money into an RRSP.

Scenario 2: I could take my $18.5K, roll it into my RRSP, which is a spousal RRSP setup with TD eFunds:
25% cdn index
25% us index
25% intl index
25% cdn bonds
This would max out my RRSP and I would let the funds grow as long as possible (after 12 more years service I will have a 52% pension). I calculated a modest return of 3% over 12 yrs that turned my $18.5K into a little over $26K.

I should also note that I curently hold over $18K in that RRSP already (with the same eFunds allocation)

My question is, what do you think is the best scenario to go with and is my 3% return realistic? Can I expect more in that same 12 yrs? Less?

I set my eFunds RRSP up roughly three years ago and have pretty much a set and forget attitude with them. If i understand it right, the markets are all low for the most part right now, so would now be the time to throw a “windfall” into the market if there ever was one?

I realize you don’t have a crystal ball, I am just hoping for some opinions from you and your readers. Thanks.

@Geoff: As you say, we can never know for sure, but a 3% annualized return for a portfolio that is 75% equities would be way, way below average. The Global Couch Potato earned more than that from 2001–10, which was one of the worst decades in history. I think it’s reasonable for your expected rate of return to be closer to 6%.